The End of Dollar Hegemony, Part I

The Daily Reckoning PRESENTS: In a speech before the U.S. House of Representatives, Congressman Ron Paul stated that the United States’ dollar dominance is coming to an end…and when this paper money runs out, wealth and political stability is lost. You can read the first part of his speech, below…


A hundred years ago it was called “dollar diplomacy.” After World War II, and especially after the fall of the Soviet Union in 1989, that policy evolved into “dollar hegemony.” But after all these many years of great success, our dollar dominance is coming to an end.

It has been said, rightly, that he who holds the gold makes the rules. In earlier times it was readily accepted that fair and honest trade required an exchange for something of real value.

First it was simply barter of goods. Then it was discovered that gold held a universal attraction, and was a convenient substitute for more cumbersome barter transactions. Not only did gold facilitate exchange of goods and services, it served as a store of value for those who wanted to save for a rainy day.

Though money developed naturally in the marketplace, as governments grew in power they assumed monopoly control over money. Sometimes governments succeeded in guaranteeing the quality and purity of gold, but in time governments learned to outspend their revenues. New or higher taxes always incurred the disapproval of the people, so it wasn’t long before Kings and Caesars learned how to inflate their currencies by reducing the amount of gold in each coin – always hoping their subjects wouldn’t discover the fraud. But the people always did, and they strenuously objected.

This helped pressure leaders to seek more gold by conquering other nations. The people became accustomed to living beyond their means, and enjoyed the circuses and bread. Financing extravagances by conquering foreign lands seemed a logical alternative to working harder and producing more. Besides, conquering nations not only brought home gold, they brought home slaves as well. Taxing the people in conquered territories also provided an incentive to build empires. This system of government worked well for a while, but the moral decline of the people led to an unwillingness to produce for themselves. There was a limit to the number of countries that could be sacked for their wealth, and this always brought empires to an end. When gold no longer could be obtained, their military might crumbled. In those days those who held the gold truly wrote the rules and lived well.

That general rule has held fast throughout the ages. When gold was used, and the rules protected honest commerce, productive nations thrived. Whenever wealthy nations – those with powerful armies and gold – strived only for empire and easy fortunes to support welfare at home, those nations failed.

Today the principles are the same, but the process is quite different. Gold no longer is the currency of the realm; paper is. The truth now is: “He who prints the money makes the rules” – at least for the time being. Although gold is not used, the goals are the same: compel foreign countries to produce and subsidize the country with military superiority and control over the monetary printing presses.

Since printing paper money is nothing short of counterfeiting, the issuer of the international currency must always be the country with the military might to guarantee control over the system. This magnificent scheme seems the perfect system for obtaining perpetual wealth for the country that issues the de facto world currency. The one problem, however, is that such a system destroys the character of the counterfeiting nation’s people – just as was the case when gold was the currency and it was obtained by conquering other nations. And this destroys the incentive to save and produce, while encouraging debt and runaway welfare.

The pressure at home to inflate the currency comes from the corporate welfare recipients, as well as those who demand handouts as compensation for their needs and perceived injuries by others. In both cases personal responsibility for one’s actions is rejected.

When paper money is rejected, or when gold runs out, wealth and political stability are lost. The country then must go from living beyond its means to living beneath its means, until the economic and political systems adjust to the new rules – rules no longer written by those who ran the now defunct printing press.

“Dollar Diplomacy,” a policy instituted by William Howard Taft and his Secretary of State Philander C. Knox, was designed to enhance U.S. commercial investments in Latin America and the Far East. McKinley concocted a war against Spain in 1898, and (Teddy) Roosevelt’s corollary to the Monroe Doctrine preceded Taft’s aggressive approach to using the U.S. dollar and diplomatic influence to secure U.S. investments abroad. This earned the popular title of “Dollar Diplomacy.” The significance of Roosevelt’s change was that our intervention now could be justified by the mere “appearance” that a country of interest to us was politically or fiscally vulnerable to European control. Not only did we claim a right, but even an official U.S. government “obligation” to protect our commercial interests from Europeans.

This new policy came on the heels of the “gunboat” diplomacy of the late 19th century, and it meant we could buy influence before resorting to the threat of force. By the time the “dollar diplomacy” of William Howard Taft was clearly articulated, the seeds of American empire were planted. And they were destined to grow in the fertile political soil of a country that lost its love and respect for the republic bequeathed to us by the authors of the Constitution. And indeed they did. It wasn’t too long before dollar “diplomacy” became dollar “hegemony” in the second half of the 20th century.

This transition only could have occurred with a dramatic change in monetary policy and the nature of the dollar itself.

Congress created the Federal Reserve System in 1913. Between then and 1971 the principle of sound money was systematically undermined. Between 1913 and 1971, the Federal Reserve found it much easier to expand the money supply at will for financing war or manipulating the economy with little resistance from Congress – while benefiting the special interests that influence government.

Dollar dominance got a huge boost after World War II. We were spared the destruction that so many other nations suffered, and our coffers were filled with the world’s gold. But the world chose not to return to the discipline of the gold standard, and the politicians applauded. Printing money to pay the bills was a lot more popular than taxing or restraining unnecessary spending. In spite of the short-term benefits, imbalances were institutionalized for decades to come.

The 1944 Bretton Woods agreement solidified the dollar as the preeminent world reserve currency, replacing the British pound. Due to our political and military muscle, and because we had a huge amount of physical gold, the world readily accepted our dollar (defined as 1/35th of an ounce of gold) as the world’s reserve currency. The dollar was said to be “as good as gold,” and convertible to all foreign central banks at that rate. For American citizens, however, it remained illegal to own. This was a gold-exchange standard that from inception was doomed to fail.

The U.S. did exactly what many predicted she would do. She printed more dollars for which there was no gold backing. But the world was content to accept those dollars for more than 25 years with little question – until the French and others in the late 1960s demanded we fulfill our promise to pay one ounce of gold for each $35 they delivered to the U.S. Treasury. This resulted in a huge gold drain that brought an end to a very poorly devised pseudo-gold standard.

It all ended on August 15, 1971, when Nixon closed the gold window and refused to pay out any of our remaining 280 million ounces of gold. In essence, we declared our insolvency and everyone recognized some other monetary system had to be devised in order to bring stability to the markets.

Amazingly, a new system was devised which allowed the U.S. to operate the printing presses for the world reserve currency with no restraints placed on it – not even a pretense of gold convertibility, none whatsoever! Though the new policy was even more deeply flawed, it nevertheless opened the door for dollar hegemony to spread.

Realizing the world was embarking on something new and mind boggling, elite money managers, with especially strong support from U.S. authorities, struck an agreement with OPEC to price oil in U.S. dollars exclusively for all worldwide transactions. This gave the dollar a special place among world currencies and in essence “backed” the dollar with oil. In return, the U.S. promised to protect the various oil-rich kingdoms in the Persian Gulf against threat of invasion or domestic coup. This arrangement helped ignite the radical Islamic movement among those who resented our influence in the region. The arrangement gave the dollar artificial strength, with tremendous financial benefits for the United States. It allowed us to export our monetary inflation by buying oil and other goods at a great discount as dollar influence flourished.

This post-Bretton Woods system was much more fragile than the system that existed between 1945 and 1971. Though the dollar/oil arrangement was helpful, it was not nearly as stable as the pseudo gold standard under Bretton Woods. It certainly was less stable than the gold standard of the late 19th century.

During the 1970s the dollar nearly collapsed, as oil prices surged and gold skyrocketed to $800 an ounce. By 1979 interest rates of 21% were required to rescue the system. The pressure on the dollar in the 1970s, in spite of the benefits accrued to it, reflected reckless budget deficits and monetary inflation during the 1960s. The markets were not fooled by LBJ’s claim that we could afford both “guns and butter.”

Once again the dollar was rescued, and this ushered in the age of true dollar hegemony lasting from the early 1980s to the present. With tremendous cooperation coming from the central banks and international commercial banks, the dollar was accepted as if it were gold.

Fed Chair Alan Greenspan, on several occasions before the House Banking Committee, answered my challenges to him about his previously held favorable views on gold by claiming that he and other central bankers had gotten paper money – i.e. the dollar system – to respond as if it were gold. Each time I strongly disagreed, and pointed out that if they had achieved such a feat they would have defied centuries of economic history regarding the need for money to be something of real value. He smugly and confidently concurred with this.

In recent years central banks and various financial institutions, all with vested interests in maintaining a workable fiat dollar standard, were not secretive about selling and loaning large amounts of gold to the market even while decreasing gold prices raised serious questions about the wisdom of such a policy. They never admitted to gold price fixing, but the evidence is abundant that they believed if the gold price fell it would convey a sense of confidence to the market, confidence that they indeed had achieved amazing success in turning paper into gold.

Increasing gold prices historically are viewed as an indicator of distrust in paper currency. This recent effort was not a whole lot different than the U.S. Treasury selling gold at $35 an ounce in the 1960s, in an attempt to convince the world the dollar was sound and as good as gold. Even during the Depression, one of Roosevelt’s first acts was to remove free market gold pricing as an indication of a flawed monetary system by making it illegal for American citizens to own gold. Economic law eventually limited that effort, as it did in the early 1970s when our Treasury and the IMF tried to fix the price of gold by dumping tons into the market to dampen the enthusiasm of those seeking a safe haven for a falling dollar after gold ownership was re-legalized.

Once again the effort between 1980 and 2000 to fool the market as to the true value of the dollar proved unsuccessful. In the past 5 years the dollar has been devalued in terms of gold by more than 50%. You just can’t fool all the people all the time, even with the power of the mighty printing press and money creating system of the Federal Reserve.

Even with all the shortcomings of the fiat monetary system, dollar influence thrived. The results seemed beneficial, but gross distortions built into the system remained. And true to form, Washington politicians are only too anxious to solve the problems cropping up with window dressing, while failing to understand and deal with the underlying flawed policy. Protectionism, fixing exchange rates, punitive tariffs, politically motivated sanctions, corporate subsidies, international trade management, price controls, interest rate and wage controls, super-nationalist sentiments, threats of force, and even war are resorted to-all to solve the problems artificially created by deeply flawed monetary and economic systems.


Congressman Ron Paul
for The Daily Reckoning

Editor’s Note: You can read the second part of Dr. Paul’s speech in the Weekend Edition of The Daily Reckoning.

Congressman Ron Paul of Texas enjoys a national reputation as the premier advocate for liberty in politics today. Dr. Paul is the leading spokesman in Washington for limited constitutional government, low taxes, free markets, and a return to sound monetary policies based on commodity-backed currency. He is known among both his colleagues in Congress and his constituents for his consistent voting record in the House of Representatives: Dr. Paul never votes for legislation unless the proposed measure is expressly authorized by the Constitution. In the words of former Treasury Secretary William Simon, Dr. Paul is the “one exception to the Gang of 535” on Capitol Hill.

To learn more about Dr. Paul, see here:

Congressman Ron Paul

Momento mori…

Yesterday, a smallish crack appeared in the Great Wall of Shanghai. Prices on the Shanghai exchange fell 6.5%.

But as far as we know, no one was injured by a body falling from one of the skyscrapers in the financial district.

“Markets shrug off Shanghai tumble,” says the headline in today’s Financial Times.

Things are getting more interesting in the financial markets…in the sense of the old Chinese curse: May you live in interesting times. But every curse comes back to damn the cursor. Here at the Daily Reckoning, we watch the interesting new developments from what seems like a safe distance. We own no Chinese stocks. We don’t even own many U.S. stocks. Our little nest egg is in property…and the family business. It is all interesting to us…entertaining even.

But wait…our business is financial publishing. What will happen when the world loses interest in finance? Will our loyal dear readers, both of them, find other things to read?

We can’t worry about that…there are more interesting things to reckon with. And what we find most interesting right now is that the risks of financial calamity have gone way up…and no one seems very interested.

“There is so much money around…unbelievable amounts of money; I think this expansion has a lot further to go,” said a dinner companion on Tuesday night. Our friend was previously chairman of the London office of one of the world’s leading investment banks. Now, he heads up a section of one of the largest commercial banks in the world.

“I’ve never seen anything like it. And I don’t necessarily like it. I just don’t think it’s going to stop any time soon.”

‘Why It May Not Stop Soon’ has been a regular subject of these Daily Reckoning columns…along with a steady interest in the companion subject: ‘Why It Will Stop Tomorrow.’ Of course, we don’t know when it will stop. But we know it will. At least, we strongly believe it will. All credit expansions eventually end in credit contractions.

All asset prices go down as well as up. And all paper money, sooner or later, ends up as decoration.

Our old friend Doug Casey once gave us a whole collection of defunct paper money, mounted and framed. We had it on the wall of our office. Old currencies – like Confederate dollars and German Reichsmarks – hung on our wall, like antelope heads…dead…trophies from a monetary safari.

In the Middle Ages, scholars used to keep a skull on their desks – a memento mori…reminding them of what lay ahead. We kept our currencies. Also on the wall was a great chart/map, illustrating Napoleon’s disastrous campaign against Russia. A wide black band began at the Russian border. As it moved east, it grew narrower and narrower – measured by the number of troops still on the march – until it reached Moscow. Then, of course, Moscow was burned. Bonaparte figured he would be trapped in the burned out Russian capital for the bitter winter. He beat a retreat. So, the black line reversed to the West, growing suddenly thinner and thinner, with each battle and each mile along the way.

Also on the map, at the bottom, the cartographer recorded the temperatures. As the poor men tramped along – over miles – it grew colder and colder…with the temperature falling to negative degrees. The troops set houses on fire to try to warm their hands…and froze in the night when the flames died down. By the time the Grande Armée recrossed the Neman River, the black band had become a mere pencil line…of the some 690,000 soldiers who followed the Corsican into Russia, only about 22,000 followed him out.

Yes, dear reader, these memento mori, remind us that everything fails and dies…currencies…armies…the best laid plans…and credit expansions. But when?

In our ‘Why It Will Stop Tomorrow’ reflections, we put the obvious, age-old insights: The market is an unpredictable, headstrong beast. He can do what he wants, when he wants. Yesterday, we saw that he could go down suddenly. Tomorrow, we may see that he can go down a lot more.

In our ‘Why It Will Not Stop Soon,’ perambulations, on the other hand, we discover something new everyday…something the world has never seen before. Never before has the planet been so globalized…with instantaneous communications all over the world. Never before has market capitalism been held in such high regard. Never before have so many new people – most of them in Asia – been so eager to enter the modern market system. And never before has the world money system, if you can call it that, rested on such a thin and wobbly reed.

(As an aside, dear reader, we have packaged all of our “Why It May Not Stop Soon”, “Why It Will Stop Tomorrow” and “Why It Will Not Stop Soon” predictions…insights…and opinions in one service: The Agora Financial Reserve. With the Reserve, you will receive all of our financial newsletters and advice for life. We’ll reopen the doors of this exclusive offer tomorrow – but only for a very limited time.)

As an aside, dear reader, we have packaged all of our “Why It May Not Stop Soon”, “Why It Will Stop Tomorrow” and “Why It Will Not Stop Soon” predictions…insights…and opinions in one service: The Agora Financial Reserve. With the Reserve, you will receive all of our financial newsletters and advice for life. We’ll reopen the doors of this exclusive offer tomorrow at a very special low price… but only for a very limited time.

More on this below…


Addison Wiggin, reporting from Charm City:

“India’s stock market hit $1 trillion earlier this week. ‘India joined the list of countries with trillion-dollar stock markets, passing another milestone in its 16-year transition from socialist backwater to the first rank of the world’s major free market economies,’ commented the Financial Times.

“‘This is indeed a historic milestone,’ adds Capital & Crisis’ Chris Mayer, ‘but also one with practical implications. A deeper capital market makes it easier for India to finance investment in the country.’ Chris has his eye on India’s dire need for infrastructure, which, it’s estimated, will cost more than $320 billion over the next five years.”

For more on the state of the Indian stock market, read today’s issue of The 5 Min. Forecast


And more thoughts…

*** The United States emits paper dollars. The dollar has no intrinsic value. Its issuer guarantees nothing. It is merely a piece of paper – a Federal Reserve Note. Present it to the Federal Reserve Bank, if you want. All you will get is another one just like it, nothing more. Still, foreigners are happy to take them in exchange for goods and service; Americans are happy to spend them. Everyone is happy. But quantity and quality vary inversely, at least in matters of international currency exchange. The more dollars out and about in the world, the less ultimate purchasing power each one has.

But here is the unique twist that makes the story of global finance, circa 2007, such a blockbuster: Many, if not most, nations earn their dollars by selling things to Americans. A falling dollar, meaning a rising local currency, puts the selling economy at a disadvantage compared to other U.S. suppliers. So, the local central bank prints up local currencies to buy the dollars – to help drive the dollar up and drive their local paper down. The weaker the dollar gets…the more local currency they need to print to help boost it up.

Result #1: Money, money, money…trillions of different kinds of it, everywhere…all the colors of the rainbow…in as many languages as Babel…and national heroes, emblems, bridges, church windows…you name it.

Result #2: Inflation in asset prices. Stocks in China have almost doubled so far this year. Andy Warhol’s handiwork is selling for millions. Prestigious houses soar.

“I don’t see how you can go wrong buying the best houses in England,” says a friend of ours, who has just bought a place in Cornwall. “Rich people from all over the world are coming in. They buy at the top end. And at the top end there just is not an unlimited supply. There’s only so much coastline, for example. It stands to reason that it will become more valuable.” (More on this tomorrow…)

But it is Result #3 that interests us now. A speculative, inflation-based asset bubble should be followed by a correction…a crash…a contraction…a slump…a vaguely punk feeling…at least a little bad hair day…but maybe even a depression! When? Where? How? We don’t know. But that’s what makes it so interesting…

*** “It’s too bad Addison Wiggin’s essay is derailed by step 3,” a DR reader wrote us yesterday, in reference to Tuesday’s essay.

“‘3. Foreign manufacturers, unable to sell at previous levels, have excess inventory, which causes an inflationary outcome.’

“Excess inventory would of course be sold at a discount; not a price increase. It would lead, as it always does, to deflationary results. It is excess money/credit and not enough inventory which leads to inflationary outcomes.”

You are correct…oops. Thanks to all of you that wrote in to point out this mistake.

*** And continuing on the demise of the dollar topic, is our old friend (and presidential hopeful) Congressman Ron Paul.

“The dollar bubble is going to collapse,” he told FOX News’ Neil Cavuto.

“I don’t think this country can do well, borrowing nearly 3 billion dollars a day from places like Japan and China to service our account deficit. And we’re leaving a 60 trillion dollar obligation to the next generation.

“My personal finances would be very good if I borrowed one million dollars every month, but some day the bills come due – and the bills will come due in this country, and we will have to pay for it.”

*** This next U.S. presidential election is “a billion-dollar battle,” says the Financial Times, the most expensive election contest in history.

Guess who’s funding a lot of the action? The financial industry, of course…and hedge funds in particular. And guess what? Eliot Spitzer…formerly a tough cop on the financial beat…is now cozying up to the financiers. As governor of New York, is he “Now a friend of Wall Street?” asks today’s International Herald Tribune.

Why would Spitzer lie down with the hounds of Wall Street? Why would the financial industry put so much money in politicians’ hands?

One answer comes to us from history…in the late Roman Empire.

“As Roman legions once sub-contracted crucifixion to private contractors and protection of the empire to barbarian clans, so the Pentagon now outsources interrogation, and calls on such companies as MPRI, AirScan and DynCorp to deploy troops, run military bases and launch coups, all in its name (and pay),” explains George Pendle, reviewing Cullen Murphy’s book, “Are We Rome?”

“A form of corporate feudalism is rapidly approaching,” Pendle continues, “in which Americans will become little more than serfs to private concerns. Civilian contractors are the barbarians of today.”

Pendle doesn’t mention public and private debt…to which Americans are also chained.

But while they drag along their heavy burdens, the elite know where the money is. The more decadent the empire becomes, the more “rents” or “spoils” are available to them through the political process – tax breaks, subsidies, contracts, tariffs, sinecures and so forth.

Every election is an “advance auction of stolen goods,” as Ambrose Bierce put it. Now, with more goods stolen than ever before, auction prices are going up.


The Daily Reckoning